Everyone would prefer the investment markets to make consistent gains without any periods of negative performance. Unfortunately, that is not the way the investment markets deliver returns.
Research into investor psychology has confirmed what we have witnessed while working with clients for over twenty years. The negative emotions tied to investment losses are significantly stronger than the positive feelings connected to investment gains. To capitalize on this difference, some financial services firms have migrated to recommending portfolios that will generate far lower returns in the hopes of reducing the number of times the firm has to report negative returns to their clients.
We believe that building a broadly diversified portfolio provides better long-term investment results for our clients. In taking this approach, we recognize the need to share the details about the benefits of our strategy over one that sacrifices upside market performance to mitigate periods of temporary market declines.
Over the last five calendar years, the S&P 500 large company stock index did not experience a single negative one-year return. However, in every one of these five years, the stock market had interim periods during which it declined. In fact, in four of the last five years, the market had an interim decline of at least 10%. Interestingly, despite these recurring dips of 10% or more, over the past five years the S&P 500 index has risen over 160%.
Some financial services firms tout abandoning stocks after a 10% decline, and then reinvesting in stocks once the decline ends but before the rise begins. That sounds great, but it requires an ability to be able to pinpoint the bottom of each decline. Thus far, not a single investment firm has demonstrated an ability to accurately time the market in this fashion on a regular basis. Market timing also guarantees much higher transaction expenses which benefits the investment firms collecting the trading fees from the investors. Research confirms that this market timing approach, which is driven by investor emotions, negatively affects investment returns.
Annual-Returns-and-Intra-Year-Declines-Slide (Click to Enlarge)
We believe that the smartest investment strategy is to stay invested through all market cycles. While we keep client portfolios fully invested, we do make minor portfolio adjustments along the way. The goal of the modifications is to either minimize an investment market risk like rising interest rates, or capture a market opportunity like changes in income tax rates which impacts the relative attractiveness of different kinds of investments. Staying invested through all market cycles requires investors to stomach short-term market declines in order to benefit from the positive returns delivered by the investment markets over longer periods of time.
The chart that follows illustrates the benefits of remaining invested in the stock market. The blue bars represent the annual returns of the S&P 500 for each of the past 34 years. The red dots indicate the largest decline in the S&P 500 during the year. As you will see, the annual returns for the S&P 500 Index have been positive in 26 of the prior 34 years. Despite the preponderance of positive years, in every one of the 34 years there was an interim decline. 2010 provides an interesting case in point. As the U.S. economy was climbing out of our most recent recession, the S&P 500 returned 13% for the year. This return exceeds its long-term average return. However, the S&P 500 had an interim decline of 16% during the year on the way to delivering the net 13% annual return. Even in 2013 when the S&P 500 returned 30%, it had a period of time during which it declined by 6%.
We share the dislike of seeing portfolio values decline when the markets decline. We hope that all of our clients continue to accept some shorter periods of market declines as we work to capture the long-term positive market returns necessary for achieving long-term financial goals.
This update is intended for the use of Oak Wealth Advisors LLC clients. This update should not be viewed as personalized investment or financial planning advice from Oak Wealth Advisors LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult Oak Wealth Advisors LLC. Past performance does not guarantee future results and all investments should be scrutinized before being implemented in a portfolio.
